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Doubt Grows About Abercrombie & Fitch

Comps took a much-larger-than-expected beating and some worry the chain has lost its edge.

Analysts are starting to lose patience with

Abercrombie & Fitch

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, even if investors are still cutting it some slack.

The cause for analysts' dissatisfaction: The apparel chain released its October sales figures on Thursday, which showed a continued decline in the company's same-store sales, troubling sales figures from the company's newest store concept and included disappointing earnings guidance. The news was bad enough that some former Abercrombie bulls admit that they are having their doubts.

Rob Wilson of Tiburon Research Group has been among those who have minimized Abercrombie's poor sales results over the last two years and pointed at its strong record of delivering earnings growth.

"I hate to throw in the towel on one month's

worth of sales figures," said Wilson. "But at some point you have to start wondering. Now's the time that I'm wondering."

(Tiburon does not do investment banking and Wilson does not hold any shares of Abercrombie.)

Wilson's not alone. Other analysts and investors expressed similar concerns about Abercrombie's business.

But investors seemed to dismiss those concerns on Thursday. Despite the poor sales figures and the disappointing guidance, Abercrombie shares traded up on Thursday, rising 24 cents, or 0.9%, to $28.41 by the close of regular trading.

One hedge fund manager, who asked not to be named, noted that despite posting mediocre sales numbers on Thursday, retailers as a whole saw little downside in their stocks. Many retailers blamed their poor sales on unusually warm weather in October that dampened demand for fall and winter clothes.


Abercrombie got a hall pass for another quarter," said the fund manager, who does not have a position in Abercrombie. "I think a lot of retailers got hall passes on the weather."

But Abercrombie may not continue to get a pass from retailers, especially if it continues to report results such as those for October.

Last month, Abercrombie's same-store sales, which compare like results open for more than one year, fell by a whopping 14%. That nearly doubled the decline expected by analysts surveyed by Thomson First Call, who had estimated that Abercrombie's comparable-store sales would drop 7.1%.

Not only did Abercrombie's sales come in far lower than expected, the company's same-store sales decline marked the ninth straight month -- and 28th out of the last 30 -- that its same-store sales have fallen.

Perhaps more troubling for Abercrombie bulls is that the company's Hollister chain performed poorly last month. The chain, which offers less expensive surfing-themed clothes, posted a decline in same-store sales in the mid-single digits, percentagewise.

Just in the last couple of months, Hollister was rumored to have posted a one-month comparable-store gain in the range of 30%, said Wilson. That rumored gain excited analysts and investors who projected that Hollister's growth could soon buoy Abercrombie's declines. But October's results may indicate that Hollister's prospects are not as bright as previously thought, analysts said.

"It's a new, young concept. The fact that it's already seen declining

comparable-store sales is concerning," said Heather Brilliant, who covers Abercrombie for Morningstar.

(Morningstar does not do investment banking and Brilliant does not hold Abercrombie shares.)

On top of the sales setbacks, Abercrombie added an earnings disappointment. The company projected that it will post profits of 49 cents to 51 cents per share for the quarter. Even if the company hits the top of that range, its earnings will fall short of the 52 cents a share that analysts surveyed by Thomson First Call had projected.

The move marked the second time Abercrombie warned analysts to cut their third-quarter estimates. At the end of the second quarter, analysts had projected that the apparel chain would earn 54 cents a share in the third quarter; Abercrombie said its results would meet or slightly beat last year's profit of 48 cents a share.

The disappointing guidance indicates that the company's earnings growth is slowing. Despite the poor same-store sales figures over the last two years, Abercrombie has been able to point to the fact that it has consistently posted year-over-year earnings growth. In fact, it's done so in an impressive 43 straight quarters.

The company's been able to boost profits by keeping its expenses under control, and by not engaging in costly discount wars with retail rivals. Abercrombie's earnings before interest and taxes stands at about 19% of sales, giving it one of the highest profit margins in the apparel retailing business.

But analysts say the company can't do much more to cut its expenses. At some point in the near future, Abercrombie's going to have to cut its prices to stimulate sales, they say.

"Without doing something to their business model, they have a problem," said the hedge fund manager.

Fortunately for Abercrombie, the company's strong margins give it some room to play, analysts say. The company could cut prices to make its clothes more cost competitive with rivals such as

American Eagle Outfitters


without taking a huge hit to earnings.

But that might only be a temporary fix, analysts warn.

The company's long-term prospects have hinged in large part on its ability to develop Hollister. However, Hollister's recent sales indicate that it might not be the growth vehicle the company would like it to be.

Until recently, the chain has been able to capitalize on the trend toward surf fashion, said Christine Andranian Sherry, who covers Abercrombie as a buy-side analyst for Bricoleur Capital. But focusing on that niche may leave it vulnerable to changes in fashion trends, she said.

"What if preppy becomes the next big thing, how do they play to that?" said Andranian Sherry, whose fund has no position on Abercrombie.

Even if Hollister resumes its earlier growth, that might not be a good thing for Abercrombie. Andranian Sherry worries that Hollister is cannibalizing sales and the company's namesake Abercrombie & Fitch stores.

"I think there's an inherent problem there," she said.

The problem is that Hollister sells its clothes at lower margins than does Abercrombie & Fitch. That means the company may be trading more profitable sales for less profitable ones.

"If that trend continues, they'll never make their

earnings numbers," said the hedge fund manager.

Wilson foresees a long period of decline for Abercrombie. Research by his firm indicates that while basic apparel products are selling well for the company, more trendy items aren't doing as well.

A parallel for Abercrombie may be


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, said Wilson. Guess was a hot brand in the late 1980s, but has since faded in the fashion scene.

"I think we'll see a similar fading away here," said Wilson. "They might have lost that fickle teen